Key Takeaways:

• When a foreign state is sued in U.S. court for breaching a commercial contract outside the U.S., whether the court has jurisdiction could turn on whether the contract required the foreign state to perform contractual obligations in the U.S.
• If a contract concerns activity outside the U.S. and does not require performance inside the U.S., breach of that contract likely will not have a “direct effect” in the U.S. under the Foreign Sovereign Immunities Act’s “commercial activity” exception to sovereign immunity.

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On July 16, 2024, the U.S. Court of Appeals for the D.C. Circuit dismissed the case Wye Oak Technology, Inc. v. Republic of Iraq and Ministry of Defense of the Republic of Iraq, for lack of subject matter jurisdiction because the defendants are immune from suit under the Foreign Sovereign Immunities Act, 28 U.S.C. § 1602, et seq. (“FSIA”). D.C. Cir. Case No. 23-7009. The court confirmed that when a foreign state breaches a contract outside the U.S., there is no “direct effect” inside the U.S. under the FSIA unless that contract required the foreign state to perform inside the U.S. or necessarily contemplated the U.S. as a place of performance.

The FSIA is the exclusive means for a U.S. court to exercise jurisdiction over a foreign state, including its political subdivisions, agencies, and instrumentalities. Argentine Rep. v. Amerada Hess Shipping Corp., 488 U.S. 428, 439 (1989). Foreign states are immune from suit in the U.S. unless at least one of the FSIA’s exceptions to sovereign immunity applies. 28 U.S.C. § 1604. The most commonly raised exception is the “commercial activity exception.” The commercial activity exception provides for subject matter jurisdiction over a foreign state in an action based:

28 U.S.C. § 1605(a)(2).

In Wye Oak, the plaintiff, a U.S. based company, entered into a contract in 2004 to rebuild the Iraqi military after the U.S.-led coalition forcibly deposed Saddam Hussein’s government. Wye Oak Slip Op. at 4-5. The plaintiff performed its obligations under the contract, but the Iraqi Ministry of Defense gave the money it owed the plaintiff to someone else. Id. at 5-6. The plaintiff, with U.S. government assistance, tried again to collect the money, but those attempts failed, and the plaintiff sued Iraq and the Ministry of Defense in U.S. district court. Id. at 6-7. The district court conducted a bench trial and awarded the plaintiff $120 million in damages. Id. at 8. The district court also ruled that it had jurisdiction over Iraq and the Ministry under the third clause of the FSIA’s commercial activity exception because the breach caused “direct effects” in the U.S. Id. at 9-10. Such direct effects included disrupting the plaintiff’s business activities in the U.S. and interfering with U.S. diplomatic, military, and foreign policy operations. Id. at 10. The defendants appealed, arguing that there was no jurisdiction because the commercial activity exception’s third clause was not satisfied. The D.C. Circuit agreed with the defendants and reversed.

Clause three of the commercial activity exception applies only when three elements are present: (1) an act outside the U.S.; (2) in connection with commercial activity elsewhere; and (3) causing a direct effect in the U.S. In Wye Oak, the D.C. Circuit had already determined, in a prior appeal, that the first and second elements were satisfied. Slip Op. at 4. The “act” occurred when the defendants breached the contract in Iraq, and the commercial activity was the underlying contract with the plaintiff, a private entity, for work in Iraq. Id. The case turned on whether the defendants’ breach caused a “direct effect” in the U.S. Id. at 4, 11. An effect is direct if it “follows as an immediate consequence of the breach.” Id. at 12. It must have “no intervening element, but, rather, flow[] in a straight line without deviation or interruption,” from the breach. Princz v. Federal Republic of Germany, 26 F.3d 1166, 1172 (D.C. Cir. 1994).

The plaintiff argued that Iraq and the Ministry of Defense’s breach of contract caused direct effects in the U.S. because those defendants failed to pay amounts owed under the contract in the U.S., their failure to pay stymied business activities for the U.S.-based plaintiff, and their breach caused diplomatic, military, and foreign policy difficulties in the U.S.. Slip Op. at 13. The D.C. Circuit rejected all of the plaintiff’s arguments and held that defendants’ breach of contract in Iraq did not cause a direct effect in the U.S.

The court determined that failure to make payment did not have a direct effect in the U.S. because the contract did not require the defendants to pay money in the U.S. or to a U.S. bank. Slip Op. at 13. Rather, the contract required the defendants to make payment “in the form and manner as directed by [the plaintiff].” Id. at 5. The plaintiff asked for payment in Iraq. Id. at 13-14. The defendants never agreed to make payment in the U.S. Id. at 14-15. The D.C. Circuit emphasized that it has “repeatedly held that when a foreign state merely has the discretion to pay in the U.S., the missing funds do not have a direct effect in the U.S.” Id. at 13.

With respect to the plaintiff’s argument that the breach disrupted the flow of commerce between the U.S. and Iraq, the court considered any such disruption to be an indirect, rather than direct effect, because the contract did not contemplate performance in the U.S. Id. at 15-18. Consequently, any disruptions to the plaintiff’s additional business plans were not direct effects of the defendants’ breach. Similarly, any negative diplomatic, military, or foreign policy impact in the U.S. was indirect because there were intervening elements between the breach and any alleged harm. Id. at 18-20.

In deciding that the defendants’ breach did not cause a “direct effect” in the U.S., the D.C. Circuit solidified the rule that whether a breach of contract outside the U.S. has a direct effect inside the U.S. turns on whether the contract requires or necessarily contemplates performance inside the U.S. Just because a plaintiff is located in the U.S. and experiences harm, that does not necessarily mean there was a direct effect in the U.S. To illustrate, if a contract does not require performance in the U.S., and if a foreign state fails to perform, then even if the plaintiff is located in the U.S., a court likely will view any effect in the U.S. as indirect. In that scenario, the third clause of the commercial activity exception would not apply, and the foreign state could be immune from suit in U.S. court. But if a foreign state enters into a contract outside the U.S. that requires payment inside the U.S., then a U.S. court might treat failure to pay as having a direct effect in the U.S., thereby subjecting the foreign state to U.S. jurisdiction. When foreign states, including their political subdivisions, agencies, and instrumentalities, enter into contracts with U.S. entities, they thus should be mindful of terms concerning location of performance, as those terms could determine whether U.S. courts have jurisdiction over potential disputes.